The Dominance of Perpetual Futures in Crypto Markets

The process of setting crypto prices is often misunderstood, with many assuming it occurs through spot trading. However, perpetual futures, also known as perpetual swaps or 'perps,' have become the dominant force in the crypto market, accounting for around 93% of all crypto futures volume. These contracts, which never expire, have been shown to lead the way in price discovery, with research indicating that they are the primary source of new information in the market. A study published in the Journal of Financial Markets found that perpetual swaps on unregulated venues were the strongest instruments for bitcoin price discovery, with regulated futures and U.S. spot exchanges reacting to, rather than leading, these moves. The evidence suggests that the derivatives market is where prices are made, with spot markets following. This phenomenon is not limited to crypto, as demonstrated by the example of SpaceX, which saw its pre-IPO valuation accurately predicted by perpetual futures contracts. The funding rate, which is the cost of holding a perpetual contract, plays a crucial role in keeping the contract price anchored to the underlying asset and provides a live readout of market sentiment. Traders closely watch the funding rate, as it can indicate the direction of the market. The use of perpetual futures contracts in pricing private companies like SpaceX has shown that these instruments can accurately predict market demand, but may be blind to supply-side factors. As the crypto market continues to evolve, the influence of perpetual futures is likely to remain a key factor in shaping prices.